Question

1) If investors get a higher expected return, they also expect

a) More risk

b) About the same risk as with a lower return

2) A method of investment analysis often used by firms not concerned with the timing of payments is the

a) Simple rate of return

b) Payback

c)Modified internal rate return

d) Internal rate of return

e) Net present value

Answer 1

(1) Answer: (a) More Risk

Higher the risk undertaken, higher the returns expected, and lesser the risk of the Project lower the returns from such project. This phenomenon is called as Risk-Return Trade off.

So, if the investor get a higher expected return, they also expect more risk.

(2) Answer: (a) Simple Rate of Return

Simple Rate of Return is computed as, Simple Rate of Return = Annual Average Net Earnings / Initial Investment.,

we can observe that timing of cash flows are not considered, All the cashflows are simply averaged and Rate of return is computed.

Payback Period is a method of analysing investment, which gives the period of time required for an investment to recover its initial outlay by way of Revenue or Savings on account of such investment. As payback period is time to recover initial outlay, time is considered for computing payback.

In NPV, all the Cashflows in the respective period are discounted at required rate of return pertaining to respective period, hence timing of cashflows has to b considered for discounting the cashflows.

In IRR , Cashflows are assumed to be reinvested for balance period at the same rate. Hence timing of cash flows are considered.

In Modified IRR , Cashflows are assumed to be reinvested for balance period at Cost of capital. Hence timing of cash flows are considered.